Abercrombie & Fitch Company

Good day and welcome to the Abercrombie & Fitch Third Quarter Fiscal Year 2020 Earnings Call. Today's conference is being recorded. If you have a question at any time during today's conference, you may signal us by pressing star 1 on your touchtone phone. We will open the call to take your questions at the end of the presentation. We ask that you limit yourself to one question during the question and answer session. At this time, I would like to turn the conference over to Pam Cantigliano. Please go ahead.

Thank you. Good morning and welcome to our third quarter 2020 earnings call. Joining me today on the call are Fran Horowitz, Chief Executive Officer, and Scott Lipesky, Chief Financial Officer. Earlier this morning, we issued our third quarter earnings release, which is available on our website at corporate.abercrombie.com under the investor section. Also available on our website is an investor presentation. Please keep in mind that any forward-looking statements made on the call are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today. A detailed discussion of these factors and uncertainties is contained in the company's filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during the call. Additional details and reconciliation of GAAP to adjusted non-GAAP financial measures are included in the release issued earlier this morning. With that, I will turn the call over to Fran. Good morning and thank you for joining us today. I hope you and your loved ones are safe and healthy and that no matter how you are planning to celebrate this holiday weekend, that you find some time to take care of yourselves and relax. Before discussing earnings, I would like to take a moment to thank our global team and vendor partners. Due to your ongoing hard work and tireless commitment, we achieved better than expected third quarter results. Total company revenues declined 5%, above our forecast for a 15-20% decline shared on our second quarter earnings call. Our balanced merchandise assortments resonated with our target customers with all brands, regions, and channels, exceeding internal sales expectations. Outperformance was achieved on reduced promotional and clearance activity, driving improved margins. At the time of our August call, there was still a significant amount of uncertainty around back to school for many students in the United States, and roughly 80% of our stores were closed in California, which is one of our largest markets. Due to this uncertainty, We expected the summer and back-to-school selling seasons to be extended and to recoup some, but not all, of the lost back-to-school sales from our traditional August peak. We saw this play out, with Omni sales in September and October exceeding our internal expectations. Digital revenues rose 43% to a third-quarter company record of $382 million. We registered meaningful year-over-year improvements in traffic to our websites and apps and Conversion and New Customer Acquisition. We realized record Q3 digital sales in over two-thirds of our categories, including the majority of our high-margin, must-win, must-grow classifications. Importantly, we achieved these records on reduced promotions and clearance, contributing to our highest Q3 digital growth margin in eight years. I am proud of how we executed and want to give a special shout-out to our supply chain team. who was able to keep up with increased digital demand despite many headwinds. Looking ahead, our team has set us up for success for this holiday season by adding a pop-up DC and additional carriers to help with anticipated demand. On the store side, we ended the quarter with 97% of our global store base open, albeit still at reduced hours. We opened stores operated at approximately 75% productivity for Q3. In-store traffic improved sequentially, although it remained down from last year. Customers who came to stores had a high intent to buy, resulting in higher year-over-year conversion and bigger baskets. Our total company growth margin rate expanded by 390 basis points, benefiting from reduced depth and breadth of promotions, as well as better FX and shrink rates. At the same time, we continue to manage expenses tightly, achieving our best Q3 operating income since 2012. Now, onto the brands. At Hollister, we were pleased with Q3, results despite the unpredictable and unprecedented back-to-school season. After a slow August, which is typically our largest month of the quarter, we rebounded nicely in September and October as California stores reopened and teens began to go back to school in varying ways nationwide. As a result, Sales declined just 7% at Hollister for the quarter, which exceeded internal expectations. Our focus on assortment architecture continued to pay off, with several of our high-margin must-haves and top 30 items outperforming, helping to drive our best Q3 gross margin rate at Hollister since 2008. From a category perspective, we saw strength in girls' dresses, sweatshirts, shorts, and knit bottoms, and guys' shorts and underwear. At Gilly Hicks, we experienced double-digit sales growth, including once again achieving over 100% digital growth from last year. Our customers continue to embrace our new active collection, Gilly Go!, as well as our comfy lounge and intimate offerings, including bralettes, cozy sleep, and a refined underwear assortment. We're excited about the significant white space that we see for Gilly. Based on its track record of sales and margin expansion, we are dedicating additional resources to accelerate growth. Throughout the quarter, we spoke with both the Hollister and Gilley customer on how to make their unique voices heard. As we sort of shifted messaging away from promotions into storytelling, we leaned heavily into our Volume On series and our Show Up for 2020 campaign, both of which focused on amplifying team voices. During the quarter, we also built on our recently introduced partnership with social media stars Charlie and Dixie D'Amelio. In late July, Charlie and Dixie helped launch our Back to School Jeans campaign along with fellow influencer Noah Pugliano and teen favorite Bill Nye the Science Guy. This highly successful campaign has had more than 5.4 billion views on TikTok and has been the number one TikTok brand campaign of the year based on brand lift metrics. In September, we introduced exclusive sweatshirts designed by the sisters which sold out. The girls now make up 9 of the top 10 posts on the Hollister Instagram account and have driven strong fan growth on both Instagram and TikTok. Our partnership with Charlie & Dixie illustrates how our Hollister team is proactively communicating with our customer on the global platforms where they spend the most time. We are building on this for holiday. With the recent launch of our Charlie & Dixie edits and our Holiday Feel Lab campaign, where they have handpicked gifts based on the feeling that you want to give, In addition, we will have two more exclusive product designs by the sisters set to drop in December. Now turning to Adelkondi. Our updated merchandise and marketing to adults and kids also resonated, with combined sales declining 2% in the quarter, which was above internal expectations. In adults, women experienced double-digit sales growth. Strength was broad-based, with denim, knit tops and bottoms, fleece, Sweaters & Skirts, all registering double-digit sales gains. In men's, we saw a great response to our new and growing 96-hour assortment, including the Traveler Jogger. Across both genders, soft AF and 96 hours continue to resonate. These are part of our strategy to build premium franchises within a broader brand. We see one way for these collections, which have been serving as strong traffic generators, attracting both new and lapsed customers, and providing a broader halo. At Abercrombie Kids, significantly improved September and October trends partially offset a tough August. Performance was driven by summer, wear now, and our back-to-school essentials, including shorts and swim in August and jeans and fleece tops in September and October. During the quarter, we shifted marketing to create excitement around product-specific moments and events for both adults and kids, while further reducing their dependence on store-wide discounts. We continue to leverage our powerful influencer network to support these events, as well as our other key moments, and we estimate that our influencers generated over a billion social media impressions in Q3. Our August Den event drove our highest DTC category day in A&S brand history, while our Fierce Day and Police Weekend both drove sales and brand awareness. Adults' and kids' marketing leaned heavily into our purpose and values. We launched the Abercrombie Equity Project with two video content series, A&F Conversations for Adults and Hanging Out with Abercrombie for Kids, both of which focus on racial and social justice. Most recently, we introduced the Megan Rapinoe by AF Conversation Series on Instagram, which explores the stigma of mental illness. To date, it has had roughly 47 million impressions. These series complement our existing work, including Kind Crew Kids, which has had over 17 million impressions since its late February launch. We're excited about the global growth opportunity across all four of our brands and see meaningful runway domestically and in APAC, where our local teams are continuing to gain traction by delivering more targeted regional product messaging. Critical to our global success is the marriage of digital and stores to offer authentic, Intimate and compelling experiences that are meaningful to our loyal local customers. Over the past several years, we've made significant progress on the key transformation initiatives we outlined at our 2018 Investor Day, which include global store network optimization, investing in digital and omnichannel capabilities, increasing the speed and efficiency of our supply chain, and continuing to evolve brand positioning while improving customer engagement. We remain committed to these initiatives and today are thrilled to announce another big step forward on store optimization with the early exit of four additional A&S flagships. We recently closed Dusseldorf and this January we will be closing our London, Paris, and Munich flagship locations. These four closures are well ahead of their natural lease expiration which range from 2022 through 2031. In February, Dusseldorf, London, and Paris will be transferred to a new tenant and Munich will be subleased. These transactions have contributed to an $8 million gain in Q3 and we do not expect material P&L impacts from these locations going forward. This announcement, combined with three previously disclosed fiscal 2020 natural lease expirations, will leave us with eight flagships at the end of the year, down from 15 at the beginning of the year. Brussels, Madrid, and Fukuoka will all close in January. With only seven locations out of our store base of 849, This announcement is meaningful on many levels. These flagships, which combined are roughly 200,000 gross square feet, or 10% of the Abercrombie & Fitch brand global square footage, have taken an outside portion of our time and resources for years and are not an accurate representation of the Abercrombie & Fitch brand today. In fiscal 2019, the seven flagships contributed a combined 1% to revenues, where a 20 basis point drag to comps and we're a 10 basis point drag operating margin. These stores accounted for roughly $30 million of store occupancy and payroll expense in 2019 and as a result of our actions, we have removed roughly $85 million of lease liabilities from our balance sheet. Fiscal year to date, performance has been meaningfully worse at these locations which are heavily dependent on tourism due to COVID-19 and associated traffic constraints. Closing these flagships is a critical part of our ongoing work to reposition our store network to more intimate, omni-enabled stores that better serve our local customer and represent our updated brand positioning. Although we are exiting these stores, we remain committed to the markets they operate in. Across the rest of our fleet, we have approximately 25% of our global lease is up for renewal as we approach year end. This gives us the opportunity to continue to level set our square footage and occupancy as we realize ongoing, meaningful increases and our already deep digital penetration, which, as a reminder, accounted for roughly a third of our revenues last year and is on track to be a much higher percent this year. We continue to believe in stores and that mindset has not changed, but as we have said before, they must be the right size, in the right location, with the right economics. Before turning the call over to Scott, I want to take a moment to share my thoughts on the holiday season. This year, there is obviously a considerable amount of uncertainty due to global COVID spikes and related store closures, as well as shipping and handling constraints and ongoing political and social unrest. As we have done since the start of the pandemic, we are focused on controlling what we can control and thoughtfully responding to what we cannot. We have remained conservative with our inventory commitments and have made key moves to maximize digital throughput while increasing Omnicam abilities including curbside, ship from store, and pop-in capacity. While we are encouraged by quarter-to-date trends, it is still early. Our historically largest volume weeks are ahead, and we may be facing further COVID-related restrictions and closures. Despite this uncertainty, our customers have been responding well to new products, and we continue to see ongoing double-digit digital growth. While we expect this holiday season to be promotional, as it always is, we have thoughtful plans in place that build off of recent successes. We also have the financial flexibility and a strong team to react to unknowns. We've made key technology, supply chain and talent investments heading into this year that have fortified our foundation. I firmly believe that our company is better positioned today than it was coming into this pandemic, and I remain as optimistic as ever about the future growth potential of our global brands. We will continue to stay close to our customer and utilize our proven playbooks, and we are confident in our ability to gain both mind share and market share. And with that, I will turn the call over to Scott.

Thanks, Fran. I'd like to start off by also thanking our global teams and our vendor partners. With your perseverance and partnership, we were able to achieve our best third quarter operating income since 2012 and generate $63 million of operating cash flow. Now on to Q3 results. Net sales of $820 million were down 5% as compared to last year. By brand, net sales declined 7% for Hollister, which includes Gilly Hicks, and 2% for Abercrombie, which includes KIDS. By region, net sales declined 4% in the U.S., 1% in EMEA, and 22% in APAC, which is our smallest region. Globally, store traffic improved sequentially but remained below last year. This was partially offset by year-over-year improvements in conversion and average transaction value across channels and 43% digital sales growth. Looking specifically at reopened store performance, third quarter global store productivity was at roughly 75% of prior year levels. By brand, on a global basis, Hollister stores outperformed Abercrombie, as Abercrombie generally has a higher digital penetration. Breaking down reopen trends further by region, starting with our largest market, the U.S. Third quarter reopen store productivity was at 75% of last year, with all but one store open at year end. Productivity was weakest in August, with a delayed back to school, and roughly 80% of our California stores closed. As of Monday, all but four of our U.S. stores are open. In EMEA, reopened store productivity was at approximately 75% of last year, with 83% of stores open at the end of the quarter. More recently, we have experienced closures in several countries on renewed COVID restrictions. As of Monday, roughly 50% of our EMEA store base was open, with closures in England, France, and other countries. As stores have reclosed, digital sales have accelerated. Looking ahead, we will continue to maximize digital demand, ship from store, and curbside pickup where available. In our smallest market, APAC, our reopen store productivity was roughly 70%, with all stores open at the end of the quarter. We have been encouraged by improvements in trend as we realize benefits from our growing team in Shanghai. Recently, Hollister was selected among 55 top-tier cross-industry brands to have ads appear in subway stations across Beijing, Shanghai, and other major cities for two weeks in October. This marked Collister's largest media exposure ever in the region and drove increased traffic to our Tmall store. As of Monday, all stores are open in the region. Moving on to gross profit, our rate of 64% was up 390 basis points to last year. Results benefited from higher AUR with promotions and clearance below last year and lower AUC. In addition, we saw 100 basis point benefit from shrink and another 90 basis point benefit from favorable FX. Turning to inventory, we entered Q4 with inventories current and down 8% to last year. We are comfortable with our positioning heading into holiday. As we move through the quarter, we plan to continue to balance gross profit rate with inventory sell-through. I'll now cover the rest of our results in an adjusted non-GAAP basis. Excluded from our non-GAAP results this year are $6 million of pre-tax asset impairment charges principally attributable to COVID. These charges adversely impacted results by $0.09. Last year, we excluded $10 million of pre-tax asset impairment charges related to certain international flagships, which adversely impacted results by $0.12. Operating expense, excluding other operating income, was $459 million as compared to $494 million last year and leveraged 120 basis points. Storage and distribution expense decreased in the dollar and rate basis, driven by a decline in store occupancy and store payroll, partially offset by increased shipping and fulfillment expense on higher digital sales. In addition, we recognize a pre-tax benefit of approximately $8 million in the current quarter, primarily due to a gain on lease assignment and updates to previously established accruals for asset retirement and severance obligations related to the four early flagship exits. Our marketing, general, and administrative expenses rose on a dollar-in rate basis, primarily driven by increased performance-based compensation partially offset by reductions in non-customer facing and in-store marketing costs. We remain focused on tightly managing expenses. We will continue to look for additional savings to enable reinvestment in our transformation initiatives as well as key customer facing areas including marketing, websites, and apps to build momentum and achieve our longer term goals. Operating income was $65 million compared to $25 million last year and included a $7 million benefit from FX. Effective tax rate was 11%. Net income per diluted share was $0.76 compared to $0.23 last year, or $0.37 on a constant currency basis. Our balance sheet remains strong. We ended the quarter with cash and cash equivalents of $813 million and total liquidity of approximately $1.2 billion. We will continue to hold higher than average cash balances to preserve flexibility in this uncertain environment. Our dividend and share repurchase programs remain suspended. We now expect capital expenditures of approximately $110 million for the year, with about half of that attributable to stores and the other half to digital technology and maintenance needs. As we have experienced profitable, accelerated digital growth, we have continued to invest in stores because they are a critical part of the omnichannel brand experience. Fiscal year to date, we have opened 12 stores and closed 17. As we approach year end, we have about a quarter of our global store base up for renewal, or over 200 leases. We've been partnering with our landlords to find a mutually beneficial and agreeable path forward. We are excited about the opportunity to further optimize our global store square footage through a combination of mall-based and flagship closures and the right-sizing of large format stores. We will continue to thoughtfully invest in smaller, omni-enabled experiences that align with our local customer shopping preferences. With roughly 50% of our leases up for renewal on a rolling two-year basis, We have the ongoing opportunity to reevaluate our store base as we continue to evolve. I'll finish up with how we are planning the fourth quarter. Reflecting ongoing global uncertainty, we are conservatively managing inventories, shifting goods between region and channel, we're optimizing distribution center capacity for increased digital demand, positioning the business to chase inventory, and tightly managing expenses while not starving our business. We will manage the near term while not taking our eyes off of our significant long-term global growth opportunity across brands. For the fourth quarter, we are planning the business as follows. Net sales could be down 5% to 10%, which assumes a deceleration from current trends. Although pleased with quarter-to-date results, including ongoing strong digital growth, there are a lot of unknowns as we head into what are traditionally our highest volume weeks of the year. With COVID numbers rising, there is the potential for a change in apparel demand and customer willingness to enter physical stores. Also, there is the looming possibility of renewed store restrictions and closures. We do not have certainty on when countries may reopen in Europe. We are planning gross profit rate to be flat up slightly from 58.2% last year. We are cautiously optimistic in our ability to drive AUR improvements in the fourth quarter through lower promotional and clearance activity. We do not expect to realize FX and shrink benefits at the same magnitude as Q3. With the exit of the Abbott Frombie & Fitch flagships and mall-based store closures, we anticipate markdown pressure as we clear through inventories at these locations. The clearance pressure should be isolated to the fourth quarter and to those locations which will be closing. Operating expense, excluding other operating income, is planned up 1% to 2% to last year's adjusted non-GAAP level of $556 million, reflecting higher fulfillment costs including elevated shipping and handling, unexpected continued strong digital demands, and carrier surcharges for holiday, which could more than offset expected ongoing store occupancy and store payroll savings. With that, operator, we are ready for questions.